With recession bets being priced out and rate-hike expectations increasing, higher-for-longer realities have gold stuck in a downtrend.
While the crowd assumed that a dovish pivot would help gold escape its bear market, we warned on Apr. 14 that the optimism would turn to pessimism. We wrote:
Market participants are pricing in ~60 basis points of rate cuts. If those cuts get priced out, the market impact is similar to the Fed raising the U.S. federal funds rate (FFR). No matter how you slice it, no cuts means the FFR stays higher for longer, and a realization should have a profound impact on the PMs…..
Mining stocks are particularly vulnerable. The rate-cut optimism contrasts the realities on the ground, and market participants are overconfident because the Fed has been wrong more than it’s been right. However, we believe the QE bulls will suffer disappointment in the months ahead.
To that point, with another week culminating with another new low for the FFR futures contract, rate-cut expectations have erased all of their bank-run gains. Consequently, our technical and fundamental thesis continues to unfold as expected.
Please see below:
To explain, the candlesticks above track the weekly movement of the December 2023 expected FFR. If the metric ends the week where it ended the Jun. 29 session, it will mark a new closing low for the cycle. In other words, the expected peak FFR continues to rise, and the hawkish re-pricing is bearish for the PMs.
Economic Bulls
Q1 U.S. real GDP was revised higher on Jun. 29, with the metric coming in at 2% versus a previously expected 1.3%. The official report stated:
“The increase in first-quarter real GDP was revised up 0.7 percentage point from the second estimate, reflecting upward revisions to exports, consumer spending, state and local government spending, and residential fixed investment that were partly offset by downward revisions to nonresidential fixed investment, federal government spending, and private inventory investment.”
As such, U.S. economic growth continues to outperform its pre-pandemic trend, and the development is bearish for assets like silver and mining stocks.
Please see below:
Furthermore, economic resiliency has resulted in a surge in Citigroup’s Economic Surprise Index. For context, a ‘surprise’ occurs when a data point outperforms economists’ consensus estimate.
Please see below:
To explain, the ascent on the right side of the chart shows how U.S. economic data has surprised to the upside in recent weeks. Moreover, we warned this would occur, as interest rates are too low to sufficiently suppress demand. Therefore, the Fed needs to continue its hawkish march, and a realization should help uplift the USD Index.
Speaking of which, Fed Chairman Jerome Powell said on Jun. 28:
“We believe there’s more restriction coming. What’s really driving it... is a very strong labor market.”
He added:
“Inflation has proven to be more persistent than we expected and not less. Of course, if that day comes when that turns around, that’ll be great. But we don’t expect that.”
Remember, we warned on Apr. 6 that the recession narrative would prove profitless. We wrote:
While the USD Index has suffered and the PMs have benefitted, the developments have only loosened financial conditions and made inflation more problematic. To win the war, long-term interest rates need to rise to suppress borrowing and consumption, and a realization supports higher real yields and a stronger USD Index. So, while the crowd believes QE is only a few months away, another disappointment should confront the pivot bulls in the months ahead.
And with Powell hinting at “consecutive” rate hikes at the following two FOMC meetings, the PMs should suffer even more if (when) the S&P 500 endures a material drawdown.
Overall, lower oil prices and base effects have been the primary drivers of the recent disinflation. But the progress has been slow, and core inflation remains well above the Fed’s 2% target. Likewise, with the U.S. housing market reaccelerating recently, it’s another indicator that interest rates must rise to slay inflation. Consequently, the liquidity drain should continue, and gold, silver, and mining stocks should suffer along the way.
Why has the U.S. economy been so resilient?
Alex Demolitor
Precious Metals Strategist